international tax issues in entertainment industry_wirc_5 july 2011

International Tax Issues in Entertainment Industry andProfit Attribution to Agency PE

Western India Regional Council - ICAI, Intensive Study Course on International Taxation, Mumbai

5 July 2011CA Romesh S A Sankhe

CA Romesh S A Sankhe2

ContentsSector Outlook

International Tax Issues ~ Entertainment Industry

Agency PE and Profit Attribution

Tax Planning Avenues

Direct Taxes Code

CA Romesh S A Sankhe

• Largest film producing market in the world with over 1,000 films released every year and more than 3 billion tickets sold annually

• The number of TV channels grown from 5 (1991) to 550 plus (2011), morethan 50% were added in the last five years

• With successful hosting of ICC Cricket World Cup and annual Indian Premier League (IPL) along with upcoming Formula One Grand Pix (F1 Race) the sports entertainment industry in India is on rise

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Sector Outlook | Industry Growth

0

500

1000

1500

2009 2010 2011 2012 2013 2014 2015

587 652 738 834957

11041275

Media & Entertainment Industry in India

Size (in INR Billions)

Projected CAGR growth of 14%

Source: FICCI-KPMG report on Entertainment 2011


• India’s association with overseas entertainment industry is growing overthe years• “Slumdog Millionaire” the film based in India and shot in India won eight

academy awards (Oscar) including best film• Awards for best original score, best song, best lyrics and best sound

mixing went to four Indian artists

• “Robot (Endhiran)” the highest grosser Indian film collected over INR 375crores, in which costumes, special effects, stunts, animations wereexecuted by foreign professionals

• Over 65 overseas players participates in a mega event of IPL which is fortwo months every year

• International sensations such as Akon, Bryan Adams, Ricky Martin allhad their concerts in various cities of India and more such artists will bevisiting India in coming months such as Lady Gaga, Shakira, etc.• All are targeting the 700 million plus Indian population below 30

• F1 Race circuit in India is scheduled at Noida in October 2011

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Sector Outlook | Global Association

With second largest population in the world and gro wing per capita income levels, India has become one of the top targ et market for global

entertainment industry

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International tax issuesin Entertainment industry



International Film Co-production (1)

• Benefits of international film co-production are as under:• the ability to pool financial resources,• access to the partner government's incentives and subsidies available

under film co-production treaty,• India has a film co-production treaty with Brazil, France, Germany, Italy,

Switzeland, United Kingdom, etc.

• access to the partner's market, or to a third market,• access to a particular project initiated by the partner,• cultural benefits; and• the opportunity to learn from the partner

• Possible tax implications in India on the co-production agreement• Exposure to constitution of ‘Association of Persons (AOP)’• If not deemed as AOP, then the foreign resident is exposed to constitution

of Permanent Establishment (PE) such as Fixed base PE, Service PE, etc.


International Film Co-production (2) | Taxation of AOP

Key tax implications are explained hereunder in brief:

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Consortium

• Not treated as ‘separate entity’ and hence profits & gains are taxable in the hands of each member separately

• Losses, if any, will be eligible for set off in the hands of each member against the gains from its other business income,

• Deduction of common business expenses possible

AOP

• Treated as a separate taxable entity and hence entire profits of the project is taxable at maximum rate of 30.90%/ 32.45%/42.02%

• Losses, if any, will not be eligible for set off in the hands of members, due to separate entity treatment

• Deduction of common business expenses difficult

• Status & taxation

• Treatment of Losses

• Head office expenses


International Film Co-production (3) | Taxation of AOP

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Consortium

• Each member can avail the treaty benefits as per its eligibility

• Members are eligible for tax credit in their host country

• Cross charges may be deductible

• Not possible for non-residents

AOP

• Treated as a separate taxable entity, hence each member is not eligible for treaty benefits

• May not be eligible for the foreign tax credit

• Remuneration to members is not allowed

• May be treated as resident, hence possible

• Applicability of tax treaty

• Treatment of foreign tax credit

• Remuneration cross charges

• Taxability of global income

If co-production contracts are indivisible contract s then it may result in

significant tax inefficiencies


International Film Co-production (4) |Alternate str ucturesComparison of key tax imperatives between these structures is as under;

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Particulars AOP LLP Ind. Co.

Maximum rate of tax on net profits incase of foreign resident members

30.90% 30.90% 32.45%

Maximum rate of tax on net profits incase of foreign resident companies as members

42.02% 30.90% 32.45%

Payment to corporate members for services rendered by them

Not allowed Not allowed Allowed

Payment of interest on capital Not allowed Allowed up to 12%

Not allowed

MAT @16.22%, [email protected]% & Deemeddividend distribution tax

Not applicable

Not applicable

Applicable

Liability of members Unlimited Limited Limited

Perpetual succession No Yes Yes

Limited Liability Partnerships (LLP) seems more fav orable, however

foreign participation in LLP can only be possible i n open sectors after

government’s approval


International Film Co-production (5) | LLP

LLPs brought under the ambit of Alternate Minimum T ax (AMT) from FY 2011-12

• Rate of tax = 19.06% on Adjusted Total Income (ATI)

• ATI = Total taxable income before deduction under chapter VI A or section 10AA [profit linked incentives]

• AMT Credit = AMT less regular income tax

• Credit carry forward = Ten years

Some key business advantages• Limited liability• Option of cash accounting• No mandatory 10% transfer to reserve unlike companies• No dividend distribution tax• Simpler entry and exist formalities

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International Film Co-production (6) | LLP

Incomes which are still out of AMT are as under:

Stream of income Normal tax Minimum Alternate Tax(Company)

AlternateMinimum Tax (LLP)

Businesses income underinvestment linked incentives

Nil 20% Nil

Capital gains exempt under section 10(38)

Nil 20% Nil

Dividends from foreign subsidiary

15% 20% Nil

Loss under income tax Act but profits as per books

Nil 20% Nil

May still be a useful alternative for holding compa nies, business availing investment linked incentives or normal tax benefits, etc.

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Shooting of Films in India

• Section 9(d) - No income accrued on shooting of films in India, if• The producer is

• An Individual who is not a Citizen of India• A firm or company not having any partner/shareholder who are citizen or resident

of India

• Producer’s operations are confined only to ‘shooting of films’ in India• Examples: Mission Impossible 4, Singularity, Eat Pray love, Slumdog

Millionaire, The Mighty Heart, etc.

• Section 9(1)(vi) - Explanation 2 specifically excludes considerationreceived towards sale, distribution or exhibition of cinematographicfilms from the ambit of royalty• Whether the same be taxable under 9(1)(i) due to ‘business connection’?• Whether the consideration towards Video rights, broadcasting rights, DTH

rights or music rights may still be taxable as ‘royalty’?

Exhibition of Films in India


Production of Films - Indian branch (1)

• At the initial stages of Indian business, the production of movies maybe undertaken by the foreign companies through its Indian branch• Branch constitutes fixed base PE in India and hence the foreign company

will be liable to tax both under the Act as well as tax treaty• Therefore, foreign producers of the Indian films will be governed by the

provisions of the income tax Act

• Section 285B - Submission of statement by producers of films• Statement in form 52A to assessing officer per film per year, within 30 days

from end of the financial year or completion of the film, whichever is earlier• Stating the details of persons to whom the aggregate annual payments

exceeds ` 50,000• Failure to comply may attract penalty of ` 100 per day under 272A


Production of Films - Indian branch (2)

• Rule 9A - Deduction of ‘Cost of Production’ for film producer• Outcome of exercise of power given to CBDT u/s 295 (1)• Recognizes the special characteristics of the production expenses which

may spread over a period beyond a year• Deduction Criteria

Censor Board

Certification

Exhibition/ Sale of rights

Release 90 days before end of the

financial year

Deduction of ‘Cost of production’

� � � Full Deduction

� � � Extent of amount realized

� � � No Deduction

• ‘Cost of Production’ includes all expenditure incurred on production ofthe film, except• Expenditure incurred on preparation of positive films• Expenditure incurred on advertisement of the film after Censor certificate• Subsidy received from the government will be reduced from the cost


Production of Films - Indian branch (3) | Other issu es

• Exhibition on a commercial basis’ - Whether it includes paid preview,direct online release, direct exhibition on Television, etc.• Yes, as per Vishesh Films Pvt. Ltd vs. Dy. CIT (Mumbai ITAT) ITA No 5569 &

5570/Mum/2004 dated 27-08-2008• The requirement of Rule 9A is exhibition of film and the mode has not been

prescribed• Hence exhibition film on Television on commercial basis clearly falls within the

ambit of Rule 9A

• ‘Remuneration to actors, artists, etc. paid in Kind’ - Whether liable toTDS/withholding tax?• Yes, as per Kanchganga Seas Foods Ltd. v. CIT (SC) [2010-TII-03-SC-INTL] and

Mr. Amitabh Bachhan Vs DCIT (Mumbai Tribunal) ITA No 1584 & 2509 /Mum/2006dated 29th November 2006

• Remuneration in kind should be properly accounted at its fair market value• It should be added to the Cost of production and the TDS needs to be deducted

• Precaution while computing cost of production - Rule 9A may notoverride other provisions of Act, hence the deduction may be subject toother conditions such as compliance of section 40(a)(ia), 40A, 43B, etc.


Film Artist and Other Professionals | Non-residents

• Income tax Act• No specific section or rule dealing with taxation of artist and professionals

in the entertainment industry except CBDT circular No. 787 dated 10February 2000

• Artist / Others• If covered under ‘fees for technical services’ [section 9(1)(vii)] or

‘royalty’ [section 9(1)(vi)] then taxable at his/her gross [email protected]% in the absence of his/her fixed base and availability of PAN

• In all the other cases, may be taxable at net income pertaining tooperations carried in India @30.90%, also may have to file return andcomply with other norms such as tax audit, etc.

• Tax treaty• Artist - Article dealing with “Artists and athletes” generally bestows the

right of taxation to the source state i.e. Indian income tax Act• Others - Those not covered under the term “Artist” may get covered

under article dealing with “Independent personal services” and generallymay not be taxable in India in the absence of their fixed base and numberof days of stay below the prescribed limit generally 180 days


Sportsperson and Sports Association (1) | Non-resid ents

• Income tax Act - Section 115BBA and CBDT circular No. 787 (supra)• Sportsperson - Person, who is neither Citizen nor resident of India, may

liable to tax on gross basis @10.30%, subject to the availability of PANon their income earned from participation in any game in India,advertisement and contribution of articles relating to any game in India

• Sports Association - Association, who is not resident of India, may liableto tax on gross basis @10.30%, subject to the availability of PAN on theirincome earned in relation to any game played in India

• Withholding of tax on above income covered under section 194E• No income tax return needs to be filed by such Sportspersons and Sports

associations, if Indian income is restricted to above mentioned sources

• Taxation of others involved in sports• Sportsperson is not defined under the Act, generally it means “a person

who takes part in sports”• Persons such as Coaches, Supports staff, Umpires, Commentators.

Cheerleaders, etc. may not be covered under section 115BBA• If covered under ‘fees for technical services’ [section 9(1)(vii)] then taxable at

his/her gross income @10.30% in the absence of his/her fixed base andavailability of PAN


Sportsperson and Sports Association (2) | Non-resid ents

• In all the other cases, may be taxable at net income pertaining to operationscarried in India @30.90%, also may have to file return and comply with othernorms such as tax audit, etc.

• If employed by foreign company then short stay exemption may be availedaccording to section 10(6)(vi)

• Tax treaty• Sportspersons - Article dealing with “Artists and athletes” generally

bestows the right of taxation to the source state i.e. Indian income tax Act• Sports Association - Income earned by such entities will be covered

under Article dealing with “other income” as stated in CBDT Circular No.787 (supra)

• Others• May get covered under article dealing with “Independent personal services”

and generally may not be taxable in India in the absence of their fixed baseand number of days of stay below the prescribed limit generally 180 days

• If employed by foreign company then exemption available under articledealing with “Dependent personal services” subject to fulfillment of prescribedconditions


Foreign Telecasting company (1)

• Income streams of foreign telecasting companies• Lease of decoders to cable operators• Subscription charges for pay channel• Advertising revenues

• Lease of decoders - May deemed to lease of commercial equipmentand hence taxable as “royalty” under the Income tax Act

• Subscription charges - May not be covered under the term “royalty”under the Income tax Act and hence may not be taxable in the absenceof non-resident’s business connection

• Advertising revenues - Position varied over the years• Option of presumptive taxation on deemed profits i.e. 10% of the gross

receipts meant for remittance [gross receipts excluding amounts retainedby advertising agent and Indian agent’s commission] - CBDT Circularno.742 dated 2 May 1996 and no.765 dated 15 April 1998

• The above circulars were withdrawn vide Circular no.6/2001 dated 5 March2001, w.e.f. 31 March 2001



• Profit attribution incase of PE• If non-resident’s operations are solely carried out through its PE in India

and if the PE is remunerated at arms length then no further profits could beattributed to the non-resident operations in India, as held in� CBDT Circular no.23/1969 dated 23 July 1969� CBDT Circular No. 5/2004 dated 28 September 2004� DIT v. Morgan Stanley and Co Inc [2007] 292 ITR 416 (SC)� Set Satellite (Singapore) v. DDIT [2008] 218 CTR 452 (Bombay HC)� Worley Parsons Services Pty. Ltd [2008] 170 Taxman 91 (AAR)� Galileo International Inc v. DDIT [2009] 180 Taxman 357 (Delhi HC)� Rolls Royce Plc v. DDIT (Delhi ITAT)� Amadeus Global Travel v. DDIT (Delhi ITAT)

Circular 23/1969 was withdrawn vide Circular no. 7 dated 22 October

2009 - Whether this withdrawal will effect the above stated position ?



• Profit attribution incase of PE• The withdrawal of circular 23/1969 may not affect the prevailing legal

position, because:• Most of the above rulings does not refer to Circular 23/1969 including Circular

5/2004 which is not yet withdrawn, the rulings were passed considering thejudicial position under section 9(1)(i)(a) which remains unchanged

• Supreme court in its ruling in the case of CCE v. M/s Ratan Melting and WiresIndustries [2008] 220 CTR 98 has held that:

“Circulars and instructions issued by the Board are no doubt binding in lawon the authorities under the respective statutes, but when the Supreme Courtor the High Court declares the law on the question arising for consideration, itwould not be appropriate for the Court to direct that the circular should begiven effect to and not the view expressed in a decision of this Court or theHigh Court. So far as the clarifications/circulars issued by the CentralGovernment and of the State Government are concerned they representmerely their understanding of the statutory provisions. They are not bindingupon the court. It is for the Court to declare what the particular provision ofstatute says and it is not for the Executive. Looked at from another angle, acircular which is contrary to the statutory provisions has really no existence inlaw.”

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Payment for Transponder (1) | New Skies ruling

Facts• Dutchco owned and operated satellites

for telecasting companies• These satellites were located outside

India and there was no presence of Dutchco in India

• The telecasting companies would relay their programmes through the communication transponders on the satellites by using their own earth stations to uplink and downlink the signals

• The transmission facility was availed of by telecasting companies according to their needs

Satellite

Downlink Earth station

Uplink Earth station

• Encryption of data into TV signals

• Uplinking of the signals

• Downlinking of the signals

• Distribution of signals in the footprint area

• Facilitating the signal transmitting process

• Amplifying the signals

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Satellite









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Issues• Whether the payment received by Dutchco

from its customers for use of its satellite will satisfy the definition of “royalty” under the India / Netherland treaty?

• Whether the services rendered by Dutchcothrough its satellite amount to “secret process” or only “process”?

• Whether the process needs to be “secret” to be treated as “royalty”?

Definition of “royalties” in India / Netherlands treaty:“….means payments…. received as aconsideration for the use of, or the right touse, any …., secret formula or process, or for information….”

The missing comma“…., secret formula or process, ….”Should this be interpreted as:

A. “secret formula or secret process” ; orB. “secret formula, or process” ?

What is the significance of there being nocomma after “formula”?



Satellite









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Ruling of Special Bench of the Tribunal

• The services rendered by Dutchcothrough its satellite amounts to a “process”

• Payment by telecasting companies is for the use of or right to use the “process”

• The process in a transponder is not secret

• Process need not be “secret” to be characterized as “royalty” under the treaty – i.e. interpretation B. (“secret formula, or process”) is correct

• The payment made to Dutchco by telecasting companies will be taxable as “royalty”



Satellite









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Comments• Key observations of the Tribunal:

• The process of uplinking and downlinking is embedded in the transponder which is used by the telecasting companies as per their needs through the earth stations owned by such companies

• Once the process in the transponder is predetermined by Dutchco, it is made available to the customers

• Dutchco has no right to interfere in the transmission process

• Without knowing the process involved in the transponder, the telecasting companies will not be able to telecast their programmes in the desired area at the desired time



Satellite









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Comments• PanAmSat decision is overruled

• The word “secret” does not qualify the word “process” in the royalty definition under the provisions of the Act as well as Tax Treaty

• Skycell decision is distinguished• In telecommunication process, customer

merely makes a request to the service provider and does not take part in the process unlike the telecasting process

• ISRO decision is distinguished• The ruling in ISRO was in context of a

navigational transponder which is different from the communication transponder used by the telecasting companies


Payment for Transponder (6) | After New Skies rulin g

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Verizon Communication Singapore (Chennai ITAT) [Jan uary 2011]• While analyzing payments made by Indian customers towards International

Private Leased Circuit or dedicated bandwidth, the tribunal observed as under:• This capacity is made available on a dedicated basis to the customer for the entire

contract period, usually a year• The amount received by tax payer from Indian customers is also for the use of a

‘process’ and would therefore qualify as royalty under Act as well as treaty• The Delhi special bench ruling in the case New Skies satellite has been referred

and relied upon

Asia Satellite Telecommunication (Delhi HC) [Januar y 2011]• The High Court observed that:

• The transponder is not distinct and separate from the satellite• The transponder is situated in orbit and merely because the satellite had a footprint in

India would not mean that the process took place in India• The payment can not be deemed to be the payment for the process

• Hence, payment for transponder are not ‘royalty’ under the Act• However , the special bench ruling in the case New Skies satellite has not been

specifically discussed, reliance placed on Isro (AAR), Ishikawajima Harima Heavy Industries (SC) and OECD commentary

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Tax Planning Avenues



Intangible Management | Overseas IPR Company

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Payment of sale proceeds

IPR holding co in offshore jurisdiction

Sale of IP located in India

Vital considerations before planningi. Domestic laws direct as well as

indirect of all the countries ii. Other incidental taxes such as

R&D cess etc.iii. IP valuationiv. Transfer Pricingv. Logistics vi. General Anti Avoidance rulesvii. Controlled Foreign Company

rules

Step 1

IPR holding co in offshore jurisdiction

Non exclusive transfer of IP

Step 2

Payment of royalty

Benefits of Royaltyi. WHT of 10.51% on repatriation

instead of 16.22% on DDTii. Claim of tax credit possible

unlike DDTiii. Deduction of expenses can be

claimed unlike DDTiv. Reduction in overall group

taxation

A Ltd A Ltd


Onshore services (1)

Whether onshore services is taxed in India ?• “Fees for technical services” under the Act includes any payment for

rendering of any managerial, technical or consultancy services• Hence, taxed @10.51% on gross income under the Act in the absence of PE

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Avenues for Mitigating onshore services taxation in India ?• Under certain tax treaties of India, services which does not make

available any technical knowledge, skill, etc. are excluded from purview of FTS and some tax treaties does not have FTS and service PE clause

• Hence services procured from tax residents of these countries may not be liable to withholding tax in the absence of non-resident’s fixed base PE in India

Tax planning is vital in terms cost saving, as most of the times service recipient bears the tax liability


Onshore services (2)

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Onshore services supply

Payment of Onshore services 100+ Withholding tax

(Grossing up) 10.51-------------------------------Total cost tothe project 110.51

B Inc

How can we save the tax of 10.51%


Payment of fees 100, no WHT (if no PE) due to tax treaty

Operating co in offshore jurisdiction


Payment of fees 100, no WHT (if no PE) due to tax treaty

B Inc

Vital considerations before planningi. Domestic laws direct

as well as indirect of all the countries

ii. Other incidental taxes such as personnel etc.

iii. Transfer Pricingiv. Logistics v. General Anti

Avoidance rulesA Ltd A Ltd


Lease of equipment (1)

Whether lease of equipments is taxed in India ?• After the amendment in finance Act 2002, “Royalty” under the Act includes

payment for use of right to use of any industrial, commercial or scientific equipments,

• Hence, taxed @10.51% on gross income under the Act in the absence of PE

Avenues for Mitigating taxation on lease of equipme nts in India ?• Most of India’s tax treaties on the line of the domestic law, includes payment

for equipment in the definition of royalty except some countries ,• Hence, equipments procured from tax resident of the above countries may not

be liable to withholding tax in the absence of non-resident’s PE in India

32

Tax planning is vital in terms cost saving, as most of the times lessee bears the tax liability while leasing the eq uipments


Lease of equipment (2)

33

Supply of equipment

Payment of Rent 100+ Withholding tax

(Grossing up) 10.51-------------------------------Total cost tothe project 110.51

B Inc

How can we save the tax of 10.51%

Supply of equipment

Payment of Rent 100, no WHT (if no PE) due to tax treaty

Operating co in offshore jurisdiction

Supply of equipment

Payment of Rent 100, no WHT (if no PE) due to tax treaty

B Inc

Vital considerations before planningi. Domestic laws direct

as well as indirect of all the countries ,

ii. Other incidental taxes such as stamp duty etc,

iii. Transfer Pricing,iv. Logistics v. General Anti

Avoidance rulesA Ltd A Ltd

34

Direct Taxes Code



Key amendments for Entertainment industry (1)

35

Tax provisions Income tax Act DTC

Use or right to use of transmission by satellite, cable, optic fiber or similar technology

Not taxable in certain cases, based on the judicial precedents

Included in ‘royalty’

the transfer of all or any rights in respect of cinematographic films

Not taxable due to specific exemption vide explanation 2 to section 9(1)(vi)

Included in ‘royalty’

Shooting of films in India by non-resident who is not a Indian citizen

Not taxable due to specific exemption vide section 9(1)(d)

There is no specific exemption

Deduction to film producer and film distributor

Rule 9A and Rule 9B

Rules are yet to be notified

Income earned from house property such Multiplex, studio, stadium, etc.

May be considered as business income, based on the judicial precedents

Included in ‘income from letting of house property’ and the standard deduction reduced to 20%

Development and transfer of a design, drawing, plan or software

Not taxable, based on the judicial precedents

Included in ‘fees for technical services’


Key amendments for Entertainment industry (2)

• Increase in withholding tax rate from 10.51% to 20% for royalty and fees for technical services - In the following cases the payments to non-residents may liable to higher withholding tax:

• India has more than 75 tax treaties, out of which over 30 tax treaties provide for a withholding tax rate of 15% to 20%

• Resident from a non tax treaty country may liable to higher withholding tax rate of 20%

• Permanent establishment - No threshold limit has been specified for construction site, building site, services rendered etc. hence following circumstances may lead to constitution of PE of foreign residents from a non-tax treaty country:

• Building site, construction site, rendering of services or leasing of equipments within India for a day or more

36

Gross-up contracts with the non-residents will have be analysed carefully, as the same may increase the cost of ove rseas transactions

37

Open house ..


38

The views expressed in this presentation are solely that of the speaker and do not constitute any kind of professional advice. These views or opinion expressed in this presentation should not be applied or used without a prior professional advice, as the review of the facts and prevailing judicial position is of utmost importance in the analysis of tax implications.

CA Romesh S A Sankhe(M) 9892 892504(E) [email protected]

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